Islamic finance has considerably expanded with an increase of Islamic financial assets from $150bn in the mid-1990's to $1800bn at the end of 2013 (Kuwait Finance House, 2014), with Islamic banks being particularly active in Middle Eastern countries and in Southeast Asia but also in Africa (Sudan, Nigeria). An emerging literature has investigated the macroeconomic impact of Islamic finance and tend to support the view of a positive influence of Islamic banking development on economic development. A major potential effect of the growth of Islamic banking is its influence of access to credit, as countries with developed Islamic banking sectors are typically emerging countries in which access to credit is a major concern.

In a recent paper, we investigate the influence of Islamic banking development on access to credit. The effect of Islamic banking development on credit availability is ambiguous. On the one hand, Islamic finance proposes specific financing instruments that may relax credit constraints. For instance, Islamic finance promotes risk-taking by banks and as such no collateral is supposed to be required when granting a loan. Therefore, as collateral requirements are a major obstacle to have financing, Islamic banking presence should favor access to credit. On the other hand, Islamic finance can also deteriorate access to credit as they can be more expensive than the conventional financing instruments. In addition, Islamic banks face refinancing constraints which can reduce their lending possibilities.

To examine this question, we perform regressions of credit availability on a set of variables including the presence of Islamic banks in the country at the firm level for a sample of 15,309 firms from 52 countries for which we have information on credit constraints and on the presence of Islamic banks. Data on Islamic banking presence come from a unique database, "IFIRST" ("Islamic Finance Recording and Sizing Tool") which provides the assets of all active Islamic banks worldwide over the period 2000-2005. In comparison with other sources of data, this database is exhaustive and does not suffer from misclassification issues. Firm-level variables come from World Bank Enterprise Survey which includes information on credit constraints at the firm level on a large set of countries.

We found that Islamic banking has overall no impact on credit constraints, while banking development and conventional banking development alleviate obstacles to financing. We consequently did not support the view that Islamic banking development would be associated as a whole to better access to credit thanks to the specific characteristics of this form of banking. However we observed that Islamic banking development exerts a positive impact on access to credit when conventional banking development is low. We therefore provided support to substitution effect between Islamic banking and conventional banking. In a nutshell, Islamic banking expansion would generate benefits in terms of access to credit for developing and emerging countries until a certain level but not for developed countries and the most advanced emerging countries in terms of financial development.

Overall, our study suggests that Islamic banking development cannot always promote credit access. However, in the least financially developed economies, Islamic finance can be a substitute to conventional banking system.

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About the Authors

Florian Léon is currently a postdoctoral research fellow at CREA (University of Luxembourg). He holds a PhD (2014) in economics at the Université d'Auvergne (France).

Laurent Weill is an Associate Professor of Economics at EM Strasbourg Business School, University of Strasbourg

At the annual African Union for Housing Finance conference in Durban, Making Finance Work for Africa spoke with Professor Jeremy Gorelick following his talk, "Positioning Cities for Housing-Related Capital Flows". Based on his professional and academic experiences in supporting sub-sovereign entities to access funds for capital-intensive projects, Prof. Gorelick has been invited to write a series of blog posts about municipal finance across Africa. The series will discuss substantive current events in the field and feature interviews with politicians, practitioners and other stakeholders.

In an era of increasing decentralization, sovereign governments across Africa are constitutionally shifting more responsibilities to cities than ever before. Along with these new mandates, though, municipal leaders are forced to be more creative in finding money to cover rapidly rising costs associated with such traditionally-central government programs as social housing, underground infrastructure, and solid waste management. Most cities continue to rely on transfers from central governments, while some have additionally opened dialogues with multilateral development finance institutions, like the African Development Bank, or bilateral development finance institutions, like the French Development Agency or the United States Agency for International Development. Still more have looked for assistance from grant-making bodies like the Rockefeller Foundation or the Bill & Melinda Gates Foundation. Other cities, like Dakar, have turned to the debt capital markets for assistance through the issuance of municipal bonds.

The municipal finance gap in Africa is over USD 25 billion per year, in contrast to the current investment capacity of African local governments-approximately USD 10 billion over ten years (according to a 2012 report, Financing Africa's Cities: The Imperative of Local Investment). Despite this pressing need, most African local governments have limited access to capital markets and private sector finance for their infrastructure projects. Essential and impartial supporting capacity - such as rating agencies - are in short supply. In addition to Dakar's attempt, only cities in South Africa (including Johannesburg, Cape Town, Tshwane and Ekurhuleni) have issued municipal bonds not backed by the central government. This can be attributed, in part, to the enabling environment created by South African government's Municipal Finance Management Act.

Contrast this with the realization that one-third of the world's urban population resides in developing countries, and this portion is growing rapidly. While only about one-tenth of the world's largest urban areas are in least developed countries, thirty of the thirty-five most rapidly growing large cities worldwide are located there. In other words, the world's fastest-expanding urban agglomerations are now in the Global South. The magnitude of the urban demographic shift is staggering. Rural-to-urban migration, combined with the effects of urban population growth, could add another 2.5 billion to the world's urban population by 2050.

The growth of cities and towns from urbanization makes functional and fiscal decentralization more viable and more necessary, and in many countries local autonomy is growing. Increasing the capacity of local officials can not only improve urban resilience and quality of life, it empowers cities and towns to contribute in important ways to national, social and economic development goals.

While the responsibilities delegated to local governments by law vary considerably from one country to the next, cities often have constitutional mandates to provide: (i) local basic services and infrastructure, including water, sanitation, public transportation, public lighting, and solid waste management, among others; (ii) resilience building, and climate mitigation and adaptation, including energy efficiency, flood management, and public building retrofitting, among others; and (iii) local social services and infrastructure, including health, education, and childcare facilities, among others.

In the past, most cities would not have had the autonomy, information technology, or knowledge of trends in the urban sector worldwide to embark on significant development projects or to prepare multi-year investment plans. But with the increasing interconnectedness of cities around the world and the growing competition among them, this has changed.

Even so, while needs and aspirations may grow, the financial options available to cities across Africa have not kept pace with the growth and increasing complexity of the cities themselves. Cities are stuck in a vicious cycle of limited resources leading to a constrained response, while the population of the city and the demand for services continue to grow.

Ironically, many local government capital investments have high economic and social returns, and therefore should be prioritized. For instance, transportation signals that reduce congestion free people's time for more productive purposes. Investments in drainage that reduce flooding in commercial areas reduce trading days lost to post-flood recovery. In these cases, domestic private capital should be available to finance municipal investments that cannot be financed through grants.

Mobilizing resources to finance investments and improve services at the municipal level is one of the most challenging aspects of local development, especially if the goal is to provide resources on market-like conditions in a sustainable manner, for instance from loans or bonds. Even when government transfers are predictable and generous (which is the exception), they are rarely adequate to finance major infrastructure improvements in growing cities. The capital investment financing that is available to local governments is often provided by national agencies whose own access to capital is highly constrained. Winning funding allocations from national budgets requires local governments to compete with line ministries and other priorities of the government in power.

As a result of these conditions, cities are realizing the importance of diversifying their resource base to meet tremendous population growth coupled with an increased list of constitutional responsibilities. Along with providing a crystallization of the current state of municipal finance across Africa, a critical purpose of this blog series will be to highlight best practices and provide a roadmap for municipal leaders eager to leave a positive legacy on their respective cities.

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About the Author

Since 2011, Professor Jeremy Gorelick has served as the Lead Technical and Financial Advisor for the City of Dakar's Dakar Municipal Finance Program. He has previously worked in structuring public debt obligations at BNP Paribas and Dresdner Kleinwort Wasserstein, and has taught classes on finance, international development and business analytics at the Johns Hopkins University since 2010. For more information on Professor Gorelick, contact him at LinkedIn.

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